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If something is unsustainable, it tends to stop

Markets this time, not blinded by professions of political will, are planning for the unavoidable

Gulf News

Politicians in developed economies are sometimes said to be at the mercy of professional bond investors, the so-called vigilantes who sell stock and therefore force yields higher (diminishing the economic feelgood factor) if not convinced of government management of the economy.

An adviser to President Clinton once notoriously referred to their all-encompassing intimidatory power when budget plans were obviated by market reaction.

In dire financial straits now, the American government feeds the monster these days, by way of the Federal Reserve, with funny money to keep it placid.

But it’s another US advisor from a previous decade, under President Nixon, whose words increasingly come to mind at present: if something is unsustainable, it tends to stop. So said Herbert Stein, referring to a ruinously deteriorating trend in the balance of payments.

Today that aphorism would seem especially apt with regard to the plight of the eurozone.

Stock markets have been volatile, with a ripple effect around the world, and with a distinct edginess about them in this limbo period.

In the Gulf a measure of that uncertainty is naturally imbued as well. As Faisal Hasan, senior vice president at Global Investment House in Kuwait, says, “There definitely seems to be a risk-off strategy in the minds of investors as the situation in Europe, at the heart of the current crisis, worsens.”

Concerns for the US and Asian economies are undoubtedly relevant, but subordinate to the euro’s demise.

Those who always flatly ruled out the possibility have already had to cross the bridge of perceiving the groundswell.

Whereas I originally wrote that sentence precisely twenty years ago this week, three months before the UK dropped out of the euro’s forerunner the exchange rate mechanism, today it is the euro itself whose very future is at stake.

Markets this time, not blinded by professions of political will, are planning for the unavoidable.

Something has to happen to the euro which accepts that the periphery countries cannot cope, will not cope, and the core can either subsidize them forever, or not. That’s the invidious choice.

ECB chief Draghi’s claim that the euro isn’t in danger -- subsequently that everything will be done to save it (a nod to perpetual German underwriting or the printing presses) -- is verging on a contrary signal.

A seismic event of some sort, whether played out slowly or quickly, is due, even if a currently sliding euro exchange rate eases the way.

If there are soon to be painful decisions, and associated trauma, how much have markets discounted already? And how will Gulf stocks fare?

After all, although the denouement of a euro shakeout will undoubtedly create a shockwave, if it has been progressively anticipated then it might even be a case of ‘selling the rumour and buying the fact’ as the drama unfolds.

We have already reflected in this column upon the greater sensitivity of regional equities to global trends during the financial crisis of the past four years, but noted only last week that GCC bonds have ironically developed some kind of protective shell.

So could there be some beneficial crossover effect sheltering the Gulf’s bourses, or do they remain very exposed?

Hasan at Global Investment House pronounces it clearly. “GCC markets remain vulnerable to international events, as we saw in the second quarter when they gave up most of their gains of the first quarter.”

A report by Kamco made the same point, attributing past negative sentiment to global deceleration and recurrent European financial stress.

Yet, perhaps fear of the imminent future can be overdone, especially with markets gradually factoring in events months if not a year ahead.

Interesting research recently from Markaz drew a temporal distinction between regional and international forces, seeming to mollify the message of doom offloaded from overseas.

While accepting that outside influences have dominated market performance, it adheres to local trends to inform an assessment of the outlook.

Head of research MR Raghu offered me further explanation. “In normal times markets respond well to internal factors like economic growth, valuation, earnings, etc.. However, during non-normal times markets may choose to give [them] less weight, and more to external factors.” That’s what occurred in the first half of 2012.

“External factors are myriad and unpredictable. It is our belief that convergence to internal factors should happen sooner rather than later, and a temporary departure from this norm in fact produces opportunities.”

It’s a brave call to suggest that ‘non-normal’ times will not continue to prevail, and reversion to positive local themes will trump gloom-laden news from the rest of the world. Raghu admits, “Predicting the timing of such convergence is risky.”

Faced with a potential disaster scenario emanating from Europe, investors must decide for themselves how to read the runes. But then it takes two or more different views to make the magic of the market.